Social Security Considerations Before an IRA Conversion

Before entering an IRA conversion from a traditional to a Roth structure, you should consider whether the additional income you generate from an account can adversely affect your taxable income. This is particularly applicable if you are considering conversion after retirement. You may be accustomed to paying one tax on your Social Security income, and the conversion can alter that tax for one or more years.

Social Security Tax Reduction

If you have started receiving Social Security benefits, due to your age or a disability, prior to your conversion, pay attention to the taxes you pay on that income. In most circumstances, you will find that converting to a new structure would actually increase your taxable income in a single year but saves you money in years to follow. First, it is important to understand that Roth IRAs are taxed differently from traditional IRAs. Traditional IRAs have a tax deferment provision. This means that you pay taxes only upon withdrawing the funds. By contrast, when you convert to a Roth, you pay taxes up front but do not owe taxes on future withdrawals.

Right now, if you are receiving income from Social Security and traditional IRA withdrawals, you are receiving two sources of taxable income. Adding these incomes together, you may be pushed into an income bracket that causes you to pay not only the taxes owed on your traditional IRA withdrawals but also on your Social Security benefits. By converting to a Roth IRA and paying the one-time tax
, you will be eliminating your taxable income in the future. You will not owe on withdrawals from the IRA, and this may also reduce your income on the whole, resulting in an elimination of Social Security income taxes.

Social Security Tax Increase

Converting from a Roth IRA to a traditional IRA is much less common than doing the reverse. You have already paid taxes on the contributing sum, so you will not receive a tax deferment on the year of your conversion. However, you will be increasing your cost basis on the investment, meaning that you will owe less in taxes in the future than if you took the deferment at this point. After the conversion, you will not pay income taxes on the investment income inside your IRA account. However, once you withdraw the funds, they are once again taxed. This can push your taxable income between your IRA and Social Security benefits into a higher level.

Preventing Tax Increases

The benefits of converting to a traditional IRA from a Roth IRA after retirement are small. Most people will not benefit from this conversion, so it is best to keep the Roth structure. If, however, you have a traditional IRA that you would like to convert to a Roth account, you may see large benefits. Remember: you will owe more on your taxes in the first year. However, the reduction in the following years will generally make up for this added expense. If you have a large amount of retirement savings in many accounts, the formula can become more complicated, and it is best to consult a tax adviser.

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